4 Simple Steps to Successfully Analyzing a Real Estate or Note Deal

Do you ever find yourself trying to create, or justify, a real estate or note deal?

This is especially common with newer investors, who may be on the fence about whether or not they found a good deal. They may even be trying to force a deal.

Recently, I was talking to a new real estate investor, and he was telling me why it was such a good deal to invest in a particular area. However, I knew from experience that the area he was referring to is a tough environment to own and manage real estate in.

Are there some folks, who can make a deal like that work? Absolutely. Sometimes, it’s just different strokes for different folks.

If you’re trying to determine whether or not you found a good deal, there are a few things you can do.

4 Simple Steps to Successfully Analyzing a Real Estate or Note Deal

1. Identify Your Investing Goals

When it comes to setting real estate or note investing goals, it’s all about figuring out what you want and how you’re going to get there.

For example, some of us just want cash flow, while others want appreciation, equity build-up or even a combination of both. Some fortunate folks who have less of a need for cash flow may be more concerned with acquiring quality, depreciable assets.

For example, I have a friend from California who is an older gentleman. He invests in brand new rental properties in Texas. He accelerates the depreciation by componentizing, and then he sells the property via a 1031 exchange approximately five years later and buys another brand new property. He does this not only to avoid the depreciation recapture tax, but also to limit the maintenance game.

2. Check the Numbers

A good exercise is to look closely at the deal, including the financing side and the potential exit strategies, to determine if the numbers make sense. How does this deal compare to others?

I’m not just talking about return here, either. I’m talking about other things too, like risk and tax implications.

When buying a house, I was always taught not to go over 65% of the ARV (After Repaired Value) all in, including acquisition costs, closing costs, repair costs and the often overlooked cost of capital. This has always served me well, especially if I couldn’t flip the property and needed to refinance it. I have deviated from this model on occasion, and I ended up leaving my money either in the property, or I cash flowed less and later regretted not having that cushion.

With notes, it’s similar. Take a performing note, for example. It’s really all about what the yield is on the payment stream. With non-performing notes, it’s more about the collateral value, in case you need to foreclose. That’s why most folks try to pay less than 65 cents on the dollar for non-performing first liens.

Sometimes you don’t know the outcome of the deal until you’re exiting said deal. But you also want to be aware of where your capital to invest is coming from.

Today, I prefer commercial real estate and notes, but when it comes to residential, I’d have to say I like blue-collar, mainstream properties that aren’t too big to manage, with decent school systems and property taxes, as well as some positive cash flow ($300 or more a month).

Although many of my properties were purchased with traditional bank financing, the method I would use today would deal with finding a distressed homeowner and solving their problem. Then the next step would be renovating and refinancing the property with permanent financing (with private or bank money), while still cash flowing.

If I can’t get a certain level of cash flow, I don’t buy it. Period. I really don’t want my real estate portfolio to cost me any money; I just want it to pay for itself. As long as that happens and I get some tax write-offs along the way, any appreciation is a bonus, and I’m happy.

With notes, it’s similar. I don’t really care what everyone else is making, but I do want to know what’s going on in the marketplace. That being said, it’s more about what I’m making and what I’m happy with.

3. Ask an Expert

The biggest lesson here, though, especially if you’re new, is to run your deal past a more experienced investor. Don’t be afraid to ask for advice.

The fellow I was talking about didn’t realize that the area he wanted to invest in had many problems. Sure, the houses were cheaper, taxes were a little lower, and they cash flowed, but what he didn’t realize is that property management in the area was a nightmare.

For example, the eviction process was brutal and took forever. The Housing Authority was very difficult and paid less than other nearby areas. The area had lien able water and gas, and finding good tenants in that area was very difficult due to the high crime rate.

4. Make a Decision

Now, once you’ve reviewed your deal to see if it meets your goals, and you’ve run it by an expert, you can’t be afraid to pull the trigger. Sure, we’ve all made some mistakes along the way, but real estate and note investing is a learn by doing business, and you have to start at some point.

The key is knowing when you have a real deal in front of you, and then acting swiftly as to not lose the opportunity.

If you’ve decided to take action, it’s really up to you now to be a good, responsible investor in the community, whether that means taking care of the property, having quality tenants, etc. It could also mean taking responsibility for your investment decisions and not blaming others for what happens.

Once you evaluated a deal and ran it by others, it is your money and your final decision. We only have ourselves to look at in the mirror.

After all, the more properties you look at and analyze, the more deals you will find.

How do you go about analyzing potential deals? Has your system ever failed you?

Let me know with a comment!

Free eBook from BiggerPockets!

Join BiggerPockets and get The Ultimate Beginner's Guide to Real
Estate Investing for FREE - read by more than 100,000 people -
AND get exclusive real estate investing tips, tricks, and techniques
delivered straight to your inbox twice weekly!

About Author

Dave Van Horn is President at PPR The Note Co. - an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the Real Estate business for 25 years, starting out as a Realtor and contractor and moving onto everything from fix and flips to Raising Private Money.

Tax consequences are especially overlooked. In fact, a lot of financial advisers deliberately fail to consider tax consequences when giving investment advice. Without a good understanding of the tax consequences, a sound financial decision cannot be made.

I agree, part of the problem is mostly everyone’s tax situation is different and the adviser probably doesn’t want to spend the time explaining tax implications or even know how to explain them. If they’re not accountants or don’t have an accounting background, you probably wouldn’t want to solely take their tax advice anyway.

A new investor is better off asking their accountant for advice on tax consequences when looking for a new investment.

I disagree that a new investor is better off asking their account for tax advice rather than a financial adviser. Of course everyone’s tax situation is different. A financial adviser is the person who sees the client’s complete picture. Not giving tax advice is a serious, even criminal, oversight.

A true story will illustrator. Not long ago there was a plumber who had faithfully been adding to his IRA over the years until he had $90,000, when his wife developed a major catastrophic illness. He had had the same financial adviser for about two decades. After the first year of illness, the health insurance company paid the cumulative bills and cancelled coverage. Of course, his wife continued to generate new bills but without coverage.

In December of that year, he asked his adviser about cashing out his IRA and using it to pay his wife’s medical bills. the adviser said sure, medical bills are one of the allowable exceptions to the early withdrawal penalty. The man actually also asked a tax adviser who basically said the same thing as the financial adviser. Neither adviser was wrong, but neither adviser advised the man properly because neither adviser knew what the other adviser knew. Each one had only part of the picture. So the man cashed out his IRA. By December 31 of that year he had paid about $5000 of the medical bills. He continued to pay the bills as they occurred.

In April, I prepared his tax return. If you follow along on a 1040, you can see what happened for that tax year. The IRA withdrawal (subject to deferred income tax) was added to his W-2 income for a total of $125,000 gross income for the year. Paid (not merely billed) medical expenses equal to 7.5% of gross income is on the taxpayer; any excess expenses is deductible. However, $5000 is within 7.5% of $125,000, so no deductible medical expenses. Also therefore no exception to early withdrawal penalty.

More than 60 days had passed, do he could not put his IRA back. Federal and state income tax and penalties gave this poor man a balance due of $45,000. With just a bit of competent tax advice from the one person who knew this man’s entire financial situation, the wh9le problem could have been avoided.

I personally went to see his financial adviser about this. His response: Not his problem or his responsibility, he said. After that, I went around to all the financial advisers in town to see if I could land a position as in-house tax adviser. No takers. They pointedly said they do nor want to be responsible for tax consequences. This is very wrong.

Another caveat: be very wary of tax advice from CPAs. I have known too many of them to give bad advice. Here is only one such example: the CPA who told my friend that if she stored one box of her home business supplies in every room of the house (including the kitchen, bathrooms, and laundry room), she could deduct her entire housing expense on her return. I told her that was not correct, but she insisted that her CPA (who should know, right?) had been doing it for at least a decade. My friend was lucky. If the IRS had ever sent a suit to take a look at her “home office.” the taxes and penalties would have ruined her. However, she retired before the IRS got around to it. She still thinks she is right because nothing happened like a kid riding his bike with no hands thinks that safe because he hasn’t had an accident yet.

The most competent tax advisers are Enrolled Agents. These are master tax advisers who have the authority to argue your case before the tax court. The best of them rarely go to court because they prepare their cases so well that the IRS accepts their documentation.

I guess my response to your comment is I think it all depends. I agree with you in some respects because the adviser should give the entire picture and in a perfect world an experienced adviser (especially one that is also a tax attorney or accountant) would hopefully give a sound opinion on taxes.

In my previous comment the keyword I should have highlighted was “solely” take tax advice from an financial adviser. What I should have explicitly said was that I think the best advice is to get multiple opinions from multiple experts because the decision ultimately is for the educated investor to make.